April 2014 Archive for Know Your Market

What’s behind the slowdown in the market’s upside momentum.

By Brendan Curran, International FC Stone

Upside momentum has stalled in the global dairy market. Supply from Europe and lower-priced competitors have begun to satiate the global demand that played a key role in driving prices higher. U.S. dairy prices have begun to adjust to find a level where the market again feels healthy.

However, the bullish fundamentals underpinning the global market have strong roots. The most widely discussed factor is the unprecedented surge in international demand that the U.S. dairy industry has opportunistically stepped up to meet.

A factor discussed less, but one that may become increasingly important, is U.S. dairy farming itself. The current market still reflects how growth of new farm investment and milk production in the U.S. has been stunted over the past few years. Only now is the domestic growth factor starting to show meager signs of coming to life.

So where does that leave us? To gain perspective, let’s focus on the fundamentals.

It was milk powder demand that sparked this rally in the first place, driving up NFDM (non-fat dry milk) and Class IV milk prices over prices for Class III and cheese, which eventually became reluctant followers. Surplus diverted into Class IV for powder production was what eventually put the squeeze on cheese.

However, five consecutive soft GDT (Global Dairy Trade) auction results have made international prices far more competitive than that of the U.S. The Chinese have been noticeably absent from the last two GDT auctions, contributing to weak results that saw. Has the bull train run out of steam?

NFDM spot prices at the CME (Chicago Mercantile Exchange) is trading in the mid-$1.80’s amid continuing soft CWAP (California Weighted Average Price) prices. Pent-up demand by those entities who were previously priced out of the market has yet to fill the void. These buyers are likely taking a conservative approach to avoid "catching a falling knife."

With increasing domestic milk production and a softer tone to the powder market, surplus milk will likely be redirected back into cheese production. Strong European production has pressured prices overseas and at some point that will have an impact here in the U.S. For the time being, however, we’re still dealing with tight inventory levels of cheese and butter that can prolong higher prices. But weakness in NFDM is expect to further weigh on other dairy product spot prices in the coming weeks.

Brendan Curran is a Risk Management Consultant with the Chicago office of INTL FCStone. INTL FCStone offers comprehensive risk-management and margin hedging programs and services to dairy producers, processors, traders and end-users. You can reach him at 312-456-3613.

What's known—and not known—about the new Margin Protection Program.

By Ken Hartzell, Dairy Gross Margin, LLC

The most frequently asked question centers around high milk prices and how long will they stick around. After all, the expression "the cure for high prices is high prices" should be coming into play. And dairies have certainly seen some of the highest milk prices ever.

The futures market continues to show discounts (lower prices) in the farther out months. As each contract nears expiration, the tendency has been for the nearby prices to rally. This seems to tell dairymen not to worry about risk management. However, increases in supply are worrying the market and should provide a tipping point eventually. Add in the toppy look of a farther out futures chart (July or later), and some alarm bells should be going off.

The next question concerns the new farm bill and its effect on the dairy industry. Familiar programs such as MILC and the export provision are gone. A new provision called MPP, or Margin Protection Program, is introduced and demands everyone’s attention. Its purpose is to protect dairies in the event of low milk prices and higher corn/soybean meal/hay prices.

We know:

A producer can choose to insure a margin of $4 per cwt. minimum up to $8 in $.50 increments.

There are different premium levels for producers below 4 million pounds of annual production (as determined by the HIGHEST of their production in the calendar years 2010, 2011, 2012) and those above 4 million pounds.

The premiums are fixed by law and will be based on the producers highest Annual Production History in the years 2011, 2012, and 2013.

A producer may insure, in 5% increments, from 25% to 90% of his production history.

Production can be increase each year by multiplying production history times 1.02.

Losses will be calculated in two-month increments. Example: January and February will be calculated together, March and April together, and payments made, based on those two months.

Producers will be able to change their percentage of milk insured and their level of margin coverage at yearly sign-up time.

Producers choose one percentage and coverage level for the entire year.

This program is "absolute." It is not about the markets comparing to what is predicted. It is about the markets performing against absolute values.

This program is highly subsidized by the government.

We DON’T know:

When you will be able to sign up for 2014, or when you will have to sign up for 2015.

If a producer signs up for the program, whether he is "locked" into the program until it expires in December 2018 or if he can opt out on a yearly basis.

For SURE, if it is on a calendar year basis or fiscal year basis. We assume it is a calendar year basis.

When the sign-up period will be in relation to the coverage period (how long in advance of coverage will you decide?)

Other things we know:

Premiums are fixed and do not reflect true risk. When futures markets give indications that MPP should pay out, premiums do not increase. In insurance, this is called "adverse selection." The closer the sign-up period is to the coverage protection period, the more is known and producers can vary their coverage accordingly.

It has been said given the "absolute" nature of MPP, this program is "a profit center" rather than risk management.

Several economists believe this program, by the nature of support it brings when prices are low, will extend the length of these periods because it will continue to encourage production.

LGM Dairy (Livestock Gross Margin-Dairy) is unaffected in the farm bill in subsidy amounts for producers or overall subsidy amounts. The one stipulation is that if you are involved in MPP, you may not be involved in LGM. Because it is not known if enrollment in MPP is continuous and annual changes are allowed, or if once enrolled, producers must stay enrolled until December 2018, it is hard to gauge the impact on LGM-Dairy.

Many of the fine points of the MPP program are yet to be determined by USDA and FSA. As one producer stated, it’s kind of like a guy being asked to go on a blind date and not knowing what rules the young lady’s father might impose.

But perhaps more importantly, this provides an alternative, or addition, to current risk management programs. There will be so many choices, it will be harder for a dairy producer to not use some form of risk management.